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Russia Fires A New Shot At The Deficit

September 04, 1994

International Finance

RUSSIA FIRES A NEW SHOT AT THE DEFICIT

Staring at the numbers flashing across his computer screen, Alexei Kurdukov whispers into his cradled receiver, listens, then types a series of numbers. "They bit!" he yells a few minutes later. Kurdukov, a 22-year-old senior trader for Troika Dialog Investment Co., has just sold $38,400 worth of three-month Russian Treasury bills.

Russia has quietly been building an important capitalist foundation: a T-bill market. Although tiny compared with the $714 billion of short-term U.S. Treasury bills outstanding, the Russian market is growing rapidly (chart) and could turn into a much-needed inflation-fighting tool for President Boris Yeltsin. The new market soaks up liquidity and lets the government finance its $10.5 billion deficit by raising capital rather than by printing ever more rubles.

BONDING. The willingness of investors--mostly domestic banks and insurers--to buy the bills in Russia's unruly economy is a sign of growing confidence that the government is making inroads against inflation. Indeed, monthly inflation is down to 6%, versus 26% a year ago. Still, the ruble-denominated, zero-coupon bonds carry heavy yields, equivalent to 25% to 30% in hard-currency terms.

Western bankers give the Central Bank of Russia credit for creating an efficient market. For two hours each weekday, Kurdukov and 54 other dealers share a room at the Moscow Interbank Currency Exchange (Micex), near Gorky Park, and trade Russian government securities by computer. All T-bill trading is done electronically under supervision of the central bank, which, as in more developed markets, may intervene by buying bills. "It's the only real, liquid securities market today in Russia," says Miljenko Horvat, president of Citibank in Moscow. Russia's fledgling stock market has little liquidity and is tainted by scandals such as the MMM

pyramid scheme. And there's no corporate bond market to speak of so far.

T-bill revenues have already made a dent in the deficit. Since the first auction in May, 1993, more than $1.5 billion has been transferred to government coffers. Over $2.25 billion of three- and six-month bills are in circulation, and daily trading volume in the secondary market exceeds $25 million. Encouraged by the success, the government plans to increase the frequency and size of auctions, broaden the distribution network, and interest investors in longer-term securities: An auction of one-year bills is set for September.

The government also plans to turn to the capital markets to help solve the $25 billion problem of interenterprise debt. Starting next month, central bank branches across Russia will begin selling $600,000 worth of one-year bonds. The government will use the revenue to pay off its debt to enterprises. The theory is that once factory managers receive the money the government owes them, they can pay their debts to each other. The new financing is intended to help halt the vicious circle of debt hobbling the government and state-owned enterprise.

But given Russia's chaotic economy, longer-term securities may not be popular. In fact, the most recent auction of six-month bills was undersubscribed by 42%. "If the government wants to increase its long-term securities, it will have to offer much higher returns," says Victor Huaco, president of LTS Finance, a Moscow-based financial boutique set up with foreign capital.

HIGH EXPECTATIONS. So far, foreign investors have only dipped their toes in the Russian T-bill market. That's partly because dealers are prohibited from selling more than 10% of their T-bill portfolio to foreigners. But some Western bankers feel the risks of investing in government debt may outweigh the potential rewards. "The T-bill market in Russia is probably the most adventurous of any fixed-income emerging market we've looked at," says Dirk Damrau, director of emerging markets research at Salomon Brothers in London.

If Yeltsin continues to prop up failing enterprises with subsidies, he could undermine the T-bill market's inflation-busting potential. Like bond markets the world over, this one will demand higher yields if inflation expectations rise. But with more and bigger auctions ahead, the central bank is clearly convinced that buyers will keep on biting.Patricia Kranz in Moscow